The EU-Russian energy relationship has been well publicized, much commented upon, but poorly understood over the past few years. There is a broad misconception (or ignorance) in the media that Russia possesses dominant leverage over the EU in the form of natural gas supplies. However, the true story is far more complicated. The EU-Russian energy relationship is one of mutual-dependence, and neither side can afford a breakdown in cooperation.Europe is undoubtedly dependent on Russian natural gas imports. Demand for natural gas has grown substantially in recent years (it is cheap, clean, and relatively abundant). As North Sea production has rapidly declined over the past decade, Europe’s reliance on imported natural gas has skyrocketed. The EU only produces approximately 46% of its current natural gas consumption, a figure projected to plummet over the next 20 years.
The growing supply/demand imbalance exposes the EU to greater external supply risks, particularly as it becomes dependent a single supplier. As of 2005, twelve member states imported at least 60% of their gas supplies from one source, of which eight relied exclusively on Russia.
Reliance on Russian natural gas is in many ways due to a lack of viable alternatives in pipeline 
gas. Russian pipelines dominate natural gas transit from within its borders and the Caspian region. With the construction of the Nord Stream pipeline (a Russo-German joint-venture) Gazprom will be able to deliver supplies directly into the heart of Western Europe, increasing its market share and the supply of affordable natural gas to EU markets. The Russian-led South Stream pipeline will dominate the supply of Caspian gas, thereby undercutting the commercial viability of the European-led Nabucco pipeline through Turkey. Russia will soon have a stranglehold on nearly all the natural gas flowing into the EU. The 2005 "gas war" with Ukraine, supply interruptions to Poland, the Czech Republic, Belarus, and Georgia have all been efforts towards this end.
gas. Russian pipelines dominate natural gas transit from within its borders and the Caspian region. With the construction of the Nord Stream pipeline (a Russo-German joint-venture) Gazprom will be able to deliver supplies directly into the heart of Western Europe, increasing its market share and the supply of affordable natural gas to EU markets. The Russian-led South Stream pipeline will dominate the supply of Caspian gas, thereby undercutting the commercial viability of the European-led Nabucco pipeline through Turkey. Russia will soon have a stranglehold on nearly all the natural gas flowing into the EU. The 2005 "gas war" with Ukraine, supply interruptions to Poland, the Czech Republic, Belarus, and Georgia have all been efforts towards this end. Fears of Russian dominance have been further stoked by Gazprom’s strategic acquisition of downstream European network assets. The company currently owns shares in nine of the bloc’s transmission system operators (37.2% of Estonia’s Estigas, 48% of Poland’s Europolgaz, 50%-minus-one share of Germany’s Wingas, and smaller shares in French and Finnish operators). Further acquisitions would position Gazprom as the dominant energy company in Europe (foreign or domestic). The backlash to Gazprom’s expansion has challenged the European Commission’s energy liberalization agenda, and divided (partly by design it must be noted) European consensus on Russian relations.
European anxiety has also been heightened by aggressive foreign policy rhetoric out of Moscow. Gazprom has threatened to diversify away from the European market if its downstream ambitions are not realized. Additionally, hardliners in Russia’s State Duma have called on the Kremlin to exercise its energy leverage more widely, an implicit reference to Europe. To many, Gazprom’s commercial strategy is now inseparable from the Kremlin’s imperial ambitions.
In this challenging and dynamic context, it is understandable that Europe feels vulnerable to Russian political objectives. However, it is essential that practitioners and observers understand that there is a degree of both perceived and actual political risk in Russian supplies. The key points:
-Russia has demonstrated a willingness (an intention) to use the "energy weapon", and one can reasonably expect that former Soviet states will continue to be targeted with supply disruptions. However, Russia’s actions have never actually threatened deliveries to Europe. In the 2005 "gas war" with Ukraine, Russia was never close to breaking its contractual obligations to Europe. In spite of Ukraine’s refusal to settle the financial aspects of the dispute, the Kremlin quickly pumped extra gas into the system and the shortfall was narrowed. While some European states experienced 1-2 days of supply disruption, this was never actually felt by consumers. Russia has demonstrated an acute sensitivity to the impact of its actions on European deliveries (going back 20 years), and has always ensured the integrity of EU contracts.
-Europeans worry that Russian supplies will be withheld for political reasons. But the real risk 
lies in the potential inability of Russia to meet its obligations. As detailed in Part I of this discussion, the Russian investment climate is quite poor, particularly in the energy sector. Russian oil production declined 10% last year, and a number of analysts have warned of an impending decline in both supply and capacity. Strikingly, Gazprom currently has to purchase Caspian gas just to fulfill its contractual obligations, an indictment on the chronic underinvestment and notoriously poor management of Gazprom. Wood Mackenzie, the energy consultancy, estimates that Gazprom will have to invest around $240bn and borrow a further $65bn just to meet European demand up to 2020. As long-term foreign finance has nearly evaporated in the aftermath of the dispute in Georgia, this will be difficult to achieve. Therefore, the real risk is that Russia will not be able to meet its supply obligations. This increases the importance of Caspian gas, and ensures that the pipeline battle in the region will take on immense geopolitical implications.
lies in the potential inability of Russia to meet its obligations. As detailed in Part I of this discussion, the Russian investment climate is quite poor, particularly in the energy sector. Russian oil production declined 10% last year, and a number of analysts have warned of an impending decline in both supply and capacity. Strikingly, Gazprom currently has to purchase Caspian gas just to fulfill its contractual obligations, an indictment on the chronic underinvestment and notoriously poor management of Gazprom. Wood Mackenzie, the energy consultancy, estimates that Gazprom will have to invest around $240bn and borrow a further $65bn just to meet European demand up to 2020. As long-term foreign finance has nearly evaporated in the aftermath of the dispute in Georgia, this will be difficult to achieve. Therefore, the real risk is that Russia will not be able to meet its supply obligations. This increases the importance of Caspian gas, and ensures that the pipeline battle in the region will take on immense geopolitical implications.-Finally, Russia is far more dependent on European demand than vice-versa. While European import dependence on Russian natural gas is forecasted to reach 40% over the coming decades, Russia is already totally dependent on European demand. The "China alternative" is distant and expensive to facilitate. Also, Gazprom relies on European revenues to finance their cheap energy provision at home, while the Russian government is dependent on tax receipts from the energy giant. Petro/Gas-roubles are critical to social stability, and any prolonged drop in prices will lead to severe pressure on an already strained pension system.
The EU-Russian energy relationship is complicated, but potentially very stable. The energy 
dialogue initiated in 2000 is critical to ensuring this stability is realized. Regimes facilitate long-term credible commitments to cooperation. Both the EU and Russia have a strong interest in energy cooperation, and the energy dialogue provides the mechanism for both sides to credibly commit to a mutually-beneficial course. European security of supply must be balanced with Russian security of demand. The risk is that the current climate will lead both sides to disengage (which is, unfortunately, happening already).
dialogue initiated in 2000 is critical to ensuring this stability is realized. Regimes facilitate long-term credible commitments to cooperation. Both the EU and Russia have a strong interest in energy cooperation, and the energy dialogue provides the mechanism for both sides to credibly commit to a mutually-beneficial course. European security of supply must be balanced with Russian security of demand. The risk is that the current climate will lead both sides to disengage (which is, unfortunately, happening already). (Lead image via The Economist)
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